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CHAPTER VI of "A Primer On Money" / continue to Chapter VII
WHO OWNS THE FEDERAL RESERVE BANKS?
In recent years, certain misconceptions and conflicts about who owns the Federal Reserve banks have developed. The reason is that when the Federal Reserve was established, it was felt that the proper way to organize it was on a capital stock basis. But the “stock” which emerged in the Federal Reserve Act was not stock in the ordinary meaning of that term at all. So recent years have been marked by a conflict between private bankers and public officials, each claiming ownership of the banks.
Do bankers believe that they own the Federal Reserve bank?
Yes. The private bankers actually advertise that they own the Federal Reserve banks. The American Bankers Association textbook, Money and Banking puts it baldly on page 234: “The member banks own the 12 Federal Reserve banks.” Money and Banking is widely used in courses for bankers sponsored by the American Bankers Association, which are attended by staff members of private banks, and other students of banking-including employees of Federal Reserve banks.
What is the position taken by Federal Reserve officials?
As a rule, Federal Reserve officials do not share this misconception about ownership of the Federal Reserve banks.
In a letter to Representative Wright Patman dated April 18, 1941, Marriner S. Eccles, Chairman of the Board of Governors, stated: “This so-called stock ownership, however, is more in the nature of an enforced subscription to the capital of the Federal Reserve banks than an ownership in the usual sense. The stock cannot be sold, transferred, or hypothecated, nor can it be voted in accordance with the par value of the shares held. Thus, the smallest member bank has an equal vote with the largest. Member banks have no right to participate in earnings above the statutory dividend, and upon liquidation any funds remaining after retirement of the stock revert to the Government.”
In hearings before the Banking and Currency Committee of the House of Representatives, June 17 and 19, 1942, Mr. Eccles stated (pp. 25, 26) :
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Mr. ECCLES. Well, the Government, in effect, for all practical purposes, owns the Federal Reserve banks.
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The viewpoint of the present Chairman of the Board of Governors, Mr. William McChesney Martin, is indicated by the following quotations from hearings before the Subcommittee on Economic Stabilization of the Joint Economic Committee in 1956:
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The CHAIRMAN. All right. No.2 is that the banks own the Federal Reserve Banking System, and it is run by the banks; it Is operated for their benefit. That is a fallacy, is it not?
Mr. MARTIN. That is a fallacy.
The CHAIRMAN. That stock, or that word “stock,” is a misnomer, is it not?
Mr. MARTIN. If you are talking about stock in terms of proprietorship, ownership -- yes.
The CHAIRMAN. Well, of course, that is what stock is; yes. Normally that is what stock is; when you say “stock,” you mean a proprietary interest of some kind, do you not?
Mr. MARTIN. In the ordinary sense, yes.
The CHAIRMAN. That is right, in the ordinary sense.
Mr. MARTIN. You and I are in agreement that it is not proprietary interest.
The CHAIRMAN. Yes. Therefore, this does not convey any proprietary interest at all, and the word “stock” is a misnomer. It is not a correct word at all. It is just an involuntary assessment that has been made on the banks as long as they are members .
The CHAIRMAN. Yes.
Therefore, the statement that the banks own the Federal Reserve System is not a correct
statement, is it?
Mr. MARTIN. The banks do not own the Federal Reserve System.
Mr. M. S. Szymczak, member of the Board of Governors, in hearings before the House Small Business Committee on Problems of Small Business Financing, April 1958, is quoted as follows:
The CHAIRMAN (Mr. Patman). Do you agree with Mr. Martin that the member banks do not own the Federal Reserve banks, and have no claim to their assets or income other than the interest payment on the so-called stock which the member banks are required to subscribe to the Federal Reserve banks?
Mr. SZYMCZAK. That is correct.
Testimony of Mr. J. L. Robertson, member of the Board of Governors, before the House Small Business Committee on Problems of Small Business Financing, April 1959, reveals the following:
Mr. ROBERTSON. I think you could operate the Federal Reserve System without the member banks
having stock in Federal Reserve banks.
Testimony of Mr. Charles N. Shepardson, member of the Board of Governors at the same hearings reveals the following:
Mr. SHEPARDSON. I think we have never contended that the central bank, the Federal Reserve
System, is owned by the commercial banks. On the contrary, we have taken every occasion in my knowledge to disabuse that idea. I don’t contend that at all.
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The position of the :Federal Reserve officials thus seems to be clear: the Federal Reserve banks are not owned by the commercial banks.
The viewpoint of the individuals quoted above has also been borne out by the presidents of the Federal Reserve banks in hearings before the House Banking and Currency Committee. However, officials of the Federal Reserve banks are sometimes inclined to take the opposite position. Does this arise from the fact that they are elected by a private bank-dominated board of directors and often are themselves ex-bankers. For example, the Federal Reserve Bank of Chicago justified expenditures not appropriate to public funds on the basis that other private businesses do the same thing-ignoring the fact that the Federal Reserve bank is a public, not a private, institution.
What do academic economists say about this ownership?
Among academic economists there seems to be a difference of opinion. Some economists hold that the banks own the Federal Reserve banks, while others agree with Federal Reserve and other public officials who maintain that the Federal Reserve banks are public organizations, not owned by the banks. Here are some quotations from college textbooks which show the general variety of opinion among college professors:
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In reality, no stock of the Federal Reserve banks bas been sold to either the public or the Government, and even the member banks have paid in only halt of their subscriptions. Thus, the Federal Reserve banks are owned wholly by their member banks, each member bank having paid in to its Federal Reserve bank an amount equal to 3 percent of its own paid-up capital and surplus (source: “The Economics of Money and Banking,” revised edition, by Lester V. Chandler, 1953, pp. 282, 283). [Emphasis added.]
Although the Federal Reserve banks are public institutions, their stock is held by the member banks (source: “Banking Systems,” edited by Benjamin H. Beckhart, 1954, p. 893). The position of the Federal Reserve banks is even harder to state precisely. They were described generally as an “Instrumentality” of the Government. In a joint statement by the presidents of the 12 Federal Reserve banks they were said to be “part of the private economy and * * * part of the functioning of the Government (although not technically a part of the Government).” It was further stated that they Were intended to be “allied to the Government but not * * * a part of the Government itself.” Allan Sproul, president of the New York Federal Reserve Bank, summed up by saying that the banks “should function somewhere between private enterprise and the Government” (source: “Principles and Practices of Money and Banking,” by Charles R. Whittlesey, 1954, pp. 244,245).
President Woodrow Wilson asked the 63d Congress for an elastic note issue and a decentralization of banking. He said, “Control must be public, not private, must be vested in the Government itself, so that the banks may be the instruments, not the masters, of business and of individual enterprise and initiative” (source: “Money and Banking,” by the Committee on Money and Banking, Pitman Publishing Co., 1957).
The member banks purchase stock in and therefore own the Federal Reserve banks of their own district (source: “Our Modern Banking and Monetary System,” by Rollin G. Thomas, 1957, p. 245).
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These quotes illustrate the disagreement and confusion which exists on the matter of Federal Reserve ownership.
What is the cause of this misunderstanding and disagreement?
The root of the trouble is the “stock” in the Federal Reserve banks which the member banks hold. The original act required that the banks invest 6 percent of their capital stock in the Federal Reserve banks.
Why was the Federal Reserve Act written to require member banks to invest in the so-called stock of the Federal Reserve banks?
The framers of the Federal Reserve Act gave many reasons, but the main reason was this: it was expected that the Federal Reserve would issue money, not mainly against Government securities as is now the practice, but against commercial and industrial loan paper --”eligible paper” as the reader knows.
This meant that the member banks would be exchanging obligations of individual commercial firms, farmers, and so on, for obligations of the U.S. Government-Federal Reserve notes. This exchange of what might be rather risky obligations for the riskless obligation of the Government, was the reason for the “stock ownership” requirement. This is why: the 12 separate Federal Reserve banks were to issue the Federal Reserve notes, with each bank passing on the quality of the loans which it would accept from the member banks in exchange for notes.
Furthermore, the administration of these banks was to be under the control of the member banks themselves, as is the case today. This meant that there was a possibility that the member banks could pass on doubtful loans made to their customers to the regional Federal Reserve bank, receiving cash in exchange. And if the Federal Reserve banks were overstocked with private promissory notes, the system’s stability was threatened. So the Government would lose by exchanging Federal Reserve notes for risky notes of the banks’ customers, and in addition could lose whatever of its general funds it had on deposit with the Federal Reserve banks. (It was expected that these banks would be the principal depositories of Treasury funds.)
It was in view of these considerations that Congress, in framing the Federal Reserve Act in 1913, required member banks of the Federal Reserve System to put a certain percentage of their capital into the; ’stock” of the Federal Reserve banks; thus “stock” was a safeguard against a misuse of the Government’s credit which was being delegated to these banks. The 1913 act placed on the member banks, furthermore, a “double liability” for their “stock” in the Federal Reserve banks. In other words, if a Federal Reserve bank failed, the member banks would lose not only their invested capital, but an equal amount of capital which they would also forfeit.
Thus, the report of the Senate Committee on Banking and Currency explaining the Federal Reserve bill had this to say: “The reasons for requiring the banks to subscribe to this stock with a double liability are -- First. To protect the large deposits of general funds which the United States will probably place with such banks. Second. To protect the United States against the extension of credit through the Federal Reserve notes, the obligations of the United States, loaned to the Federal Reserve banks against commercial bills.”
Today, the need for this safeguard has disappeared. When the Federal Reserve System began operations, it did in fact issue money against commercial loan paper, and this was its principal way of creating money from 1914 to 1921. But since then eligible paper has played so small a part in Federal Reserve credit as to be practically nonexistent: in November 1963, the collateral which the Federal Reserve banks held against outstanding Federal Reserve notes was $34,670 million. Less than one-half of 1 percent of this collateral is “eligible paper,” the other 99% percent being U.S. Government securities and gold certificates.
An additional reason for requiring the member banks to invest some of their capital in the Federal Reserve banks was given by the members of the Senate Committee on Banking and Currency who recommended the arrangement:
To justify the Government in putting on the banks the prime responsibility of administering these banks and safeguarding their own reserves and their own capital stock, and making them responsible to the country for safeguarding the welfare of the national banking system, protecting the national gold supply under the safeguard of governmental supervision.
But an equal number of members of the Senate Committee on Banking and Currency felt that stock in the Federal Reserve banks should be sold to the general public, not to the banks-as a means of drawing more capital into the banking system of the country. This way, they felt, “tens of thousands of our people will be directly interested in this great Government-controlled banking system.” This group also felt, as they stated in the committee’s report:
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It has seemed to us, moreover, wise that upon these Reserve banks the Government should have a majority of the Board of Directors.
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At that time, the amount of capital in the banking system of the United States was generally considered to be small, and both schools of thought in Congress recognized the lack of public confidence in the banking system, which encouraged people to hold money in cash, rather than in banks. The Senate committee report said that an important result of setting up the improved system of banking would be an increased public confidence in the banks and which would attract a considerable amount of money which is not now deposited in banks at all and would thus enlarge the deposits of the bank and enlarge substantially their money-creating power.
Finally, both groups in the Senate committee recognized that the 6 percent interest rate to be paid on the Federal Reserve bank stock was extremely attractive and would provide a subsidy to entice private banks to join the System. Those recommending banker control of the Federal Reserve banks said that this so-called stock would prove irresistible to banks: earning 6 percent net, free from tax, making the earning on such stock between 7 and 8 percent, which is a higher return than any bank can possibly average upon its deposits.
But, the group favoring public ownership of the stock pointed out that the stock could be sold to the public at a rate of 5 percent, and if offered to small investors, tax free, it would be a highly desirable 5 percent investment which they will eagerly take.
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What is the nature of this “stock”?
Hearings before various congressional committees have established clearly that this stock is not stock in the ordinary meaning of the term.
(1) It carries no proprietary interest. In this respect, the stock is unlike the stock of any private corporation.
(2) It cannot be sold or pledged for loans. It thus does not represent an ownership claim.
(3) In the event of the dissolution of the Federal Reserve banks, the net assets after payment of the liabilities and repayment of the stock go to the U.S. Treasury rather than the private banks.
(4) The stock docs not carry the ordinary voting rights of stock. The method of electing officers of the Federal Reserve banks is in no way connected to the amount of stock ownership. Instead each bank in a district has one vote within its class, regardless of its stock ownership.
What are the problems created by this stock ownership?
(1) The major problem is that it leads to misconceptions about the ownership and nature of the Federal Reserve banks. Private bankers are, as was indicated above, led to believe that they own the Federal Reserve and thus have the right to control it and to share in its profits.
(2) Some Federal Reserve officials have been led to believe that the funds of their banks are not public funds but funds that the officials may spend as they see fit. This argument has been used to justify spending funds of Federal Reserve banks in a manner not suited to public funds: for scholarships to employees, for Christmas gratuities to various people who are not employees of the banks, for boating trips and for other extravagances of officers of the banks.
(3) The stock is an additional cost to the taxpayers, and a subsidy to private banks. Dividends on the stock run to almost $24 million a year; except for the tax paid on them, such dividends represent a net loss to the taxpayers. If the stock did not exist the money which goes as interest would go to the taxpayers.
How can these problems be eliminated?
The logical way to eliminate these problems is to eliminate their cause: the stock. At present there is a bill before the Congress which would have the banks return this stock to the Federal Reserve banks and have the Reserve banks pay it off.
Could the Federal Reserve operate without this stock?
Yes. Although the stock was necessary in 1914, today it serves no worthwhile purpose. The statement of Board Member Robertson, quoted above, indicates that the Federal Reserve could operate just as well without the stock. This point has been well established in hearings.
Would elimination of the stock ownership change the basic structure of the Federal Reserve?
The same method of electing the boards of the Federal Reserve banks, the same requirements for membership in the Federal Reserve System, and the same organizational structure of the Federal Reserve banks could be maintained. The same check clearing and other relationships between private member banks and the Federal Reserve could exist. There is no reason to believe that the basic structure of the Federal Reserve System would be changed simply because the stock were retired, though there are many reasons for altering the System’s structure.
Is there any reasonable justification for this stock?
No. The stock has been justified on the grounds that it is traditional. Members of Congress have indicated, and rightfully, that it is their duty to change those traditions which are harmful to the Nation. It has been justified as being a symbol, though it is not clear just what the stock is symbolic of. Nor has been established that this symbol could not be maintained in another less expensive form, such as a membership certificate. Other psychological factors are supposed to be maintained by this stock ownership. These factors are largely in the realm of mysticism. No sound reason has been given for keeping this stock. The banks, of course, oppose elimination of the stock because it represents a generous gift from the taxpayers which they do not wish to give up.
Does the Federal Reserve need the money!
No. The Federal Reserve is a money-creating system. It can write a check whenever it needs money. Thus the Government is paying interest to the bankers on funds which it does not need.